China droops

As if the European crisis was not a big enough problem for the world economy, there has now emerged a “second front” — China. The ongoing slowdown in China is a double challenge. Not only does it it eliminates the possibility that China will prove to be the savior of the world, as it did so powerfully in 2009, it also adds the huge Chinese economy to the forces pulling the global economy down.

In a recent blog, the Daily Telegraph’s acerbic commentator, Ambrose Evans-Pritchard, noted that “the last thing the world needs now is a deflationary shock from China” — but then proceeded to illustrate why that eventuality is not merely likely, but already happening. He provided a list of indicators that support his contention, quoting in the process an interesting site called Zarathustra (with a daily newsletter called “Also Sprach Analyst” – you gotta love it), which presented its own “ten signs of economic trouble that China’s official data won’t tell”.

One of these, to which both Zarathustra and Evans-Pritchard attribute particular significance, is the sharp fall in revenue growth reported by casinos in Macau. Zarathustra notes that casino revenues are closely linked to the rate of Chinese GDP growth, because the money gambled by the Chinese high rollers is generated by the booming Chinese economy, via speculation in real-estate, commodities and other areas. When the pace of activity drops, the impact is felt very quickly in Macau.

For Israelis, and especially for the Israeli prime minister, this is not just an interesting anecdote. Sheldon Adelson, who has made Yisrael Hayom into the most widely-read daily in Israel, and who is a major contributor to both the Taglit (Birthright) program and to Netanyahu and the Likud, is deeply invested in Macau. The crash of 2008 had a tremendous impact on the gambling industry, in the Far East as in the US, and Adelson’s companies and casinos — and hence his personal fortune — were hammered. The massive stimulus programs launched by the Chinese government in late 2008, which played a key role in reversing the downward spiral in the global economy, fed directly and swiftly through to the gambling halls of Macau, saving the casinos and their owners from disaster.

That’s a very specific example of how the globalised economy works: Chinese contractors get cheap loans from state-run banks and make fortunes in their domestic real-estate market. They blow some of their money in Macau casinos, generating profits for the American businessmen who made the island into a bigger and gaudier version of Las Vegas — and some of these profits are in turn invested in Israeli media, or contributed to Israeli and American politicians.

Switching back from the micro to the macro, the slowdown in the Chinese economy is a game-changer for the entire world. It’s pretty clear that the rate of growth in China has slipped below 8% per annum, for the first time in many years. That sounds very high, and indeed it is for any developed economy. But when you are coming off double-digit rates of growth, 8% is a significant change for the worse and everyone has to adjust downwards.

That is the immediate issue — the ‘cyclical’ aspect of going through a slow patch which, in a normal economy, would be considered a recession. But the real problem is that this downward adjustment is likely to prove permanent. The era of growth rates in excess of 10% per annum is over for China — for many reasons, but in part because the model of growth used by China for the last twenty years, of massive investment in new plant and equipment in export-oriented industries, is no longer viable. The slump in Europe and the sluggishness of the American economy has destroyed demand growth in China’s biggest markets and exposed the vulnerability of a growth strategy based on exports to developed economies.

The pessimists with regard to China believe that over-investment has left the Chinese with massive over-capacity in virtually every area of manufacturing. This must result in deflation — and they cite the recent run of declines in the monthly price indices at both the retail and wholesale level as evidence of precisely this phenomenon. The Chinese authorities are responding to the signs of deflation by cutting interest rates and removing restrictions on banks to increase their lending — which is the textbook response, and is what the Japanese did when they faced the same threat and what the Americans are doing now.

If this effort fails and the Chinese economy continues to slow down, to growth rates of perhaps 5-6%, the deflationary impact will spread around the world, because the Chinese will cut the prices of everything they manufacture — as well as of their currency, despite the screams this devaluation will trigger in Washington — and flood global markets in an effort to generate income. Were Ambrose Evans-Pritchard Yiddish-speaking (which seems unlikely), he might have said that this the world needs like a hole in the head.

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